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This article presents a bear case for Angie's List (NASDAQ:ANGI). I'm a big believer in long short investing and wanted to do a follow-up to my previous article, which presented a bullish case for Research in Motion (RIMM), with a short idea.

Second Quarter Results

On July 25th, Angie's list released its second-quarter results. Revenue came in strong with a 75% increase over the same period in the prior year and subscribers reached an all-time high. In spite of this, the stock has been down strongly. I'm here to explain why.

On the surface, second-quarter results seemed pretty good. Subscribers reached an all-time high at over 1.4 million total subscribers. Furthermore management disclosed that it had reached over 1.5 million users by the end of July. So it seems that it is adding about 100,000 new users each month. However, despite the growth in users the company has failed to become profitable. In other words, strong top-line growth has yet to translate into a healthy bottom line and I think I know why. If you dig a little deeper into the financial statements, the second-quarter results were actually very disappointing from several angles.

Sales and Marketing Costs
The most recent quarter has brought the highest spend per new customer in the company's history. The numbers released today are very worrying. Marketing costs reached an alarmingly high $91.00 per new member over the most recent quarter. Angie's list does not seem to be achieving economies of scale despite rapid membership growth. Ad sales make up most of the company's revenue. However selling costs have risen in lockstep with ad sales revenue. Clearly there is an issue with the core business model.

Member Cancellations

Management claims that the average membership renewal rate in the second quarter was 77%. However if we dig a little deeper, we can uncover that this number is actually quite misleading. The 77% figure that management presents does not take into account monthly memberships or memberships that were canceled before their scheduled renewal date. Management does not like to report the overall cancellation rate because it is much lower than the renewal rate. However with the information given in the financial statements we can calculate it. To do so we first look at the beginning subscribers at the end of the first quarter 2012, which were 1,221,387. Over the second quarter ANGI added 305,151 gross subscribers. So if there were no cancellations the company should end up with 1,526,538 total subscribers at the end of the second quarter. However it actually only had 1,431,073; which is a difference of 95,465. This difference is the total number of cancellations. The total cancellation rate as a percentage of beginning subscribers is 7.81% per quarter or 31.26% annually (7.81 x 4 quarters). The overall renewal rate is actually less than 69% by my calculations. It seems that for every 3 new customers, about 1 customer is lost.

How Big Can it Really Get?
It seems that the law of large numbers is finally catching up with Angie's List, which will limit the company's growth going forward. There are only about 100 Million households in the USA and the target market is much, much, smaller than that. How many will they finally top out at? This is anyone's guess, but for comparison, Consumer Reports, has about 3 million subscribers. With 1.5 million subscribers, Angie's List can't keep doubling sales every year anymore as there is not much more room to grow and cancellations are so high.

High Short Selling Costs
Short selling costs a major consideration with this stock. Not only can it be difficult to obtain shares to short, the interest rate for borrowing the shares will be high as well. The interest rate to borrow ANGI shares for shorting has generally been in the 40% to 50% annual rate range since the IPO; although over the last few weeks it has dropped down into the mid 35s. Depending on your broker, your costs could be higher or lower, and you may find it hard to impossible to even obtain shares to short. I've had difficulty in several instances locating shares myself. With borrow costs so high, you may still lose money even if the stock goes down! Please keep this mind when deciding if this trade is right for you.

Disclosure: I am short ANGI.

Additional disclosure: I am Long RIMM.

Source: Angie's List: Q2 Earnings Report Shows Signs Of Trouble